In this article, we will take a look at the Buffett partnership letter dated Dec. 24, 1962.

This letter mainly deals with some important partnership tax information. However, it also touches upon 1) the performance of the stock market since November 1, 1962, and 2) partner capital accounts and commitment letters.

Since this letter is so short, I have reproduced it in its entirety below. After the text of the letter I will add a few short thoughts, and then close the article.

Quote:To All Limited Partners:

The following tax information is very important and should either be clearly understood by you if you prepare your own return or given to your tax advisor if he prepares your return.

(1) If you have received any distributions from the partnership during the year, disregard such amounts for federal income tax purposes.

(2) All items which should be included on your federal income tax return will be sent to you by the 20th of January either by me or directly from our auditors. You will be informed as to the proper handling of these items on your return. Do not file your tax return until you have this information.

(3) Nebraska residents need not report their interest in the partnership on their Nebraska Personal Property Return. The Partnership pays personal property taxes directly; the individual partners do not need to pay them.

(4) If potential income from the partnership (say 15% or 20% of your equity at market value) is a significant portion of your total income, the safe course to follow in preparing 1963 quarterly estimates is to pay on the basis of your actual 1962 tax. This will avoid possible penalties for underestimating. You are liable on your quarterly estimates for your proportionate share of partnership income. If your estimate for the current year is the same as the actual tax paid for the preceding year, you cannot be penalized for underestimating.

If you have any questions at all about this information, be sure to let me know.

(3) A statement as to the market value of your interest on January 1, 1963, giving effect to additions and withdrawals, if any, in the early days of January.

(4) My inimitable annual letter.

Since my letter of November 1st, the stock market has moved substantially higher; therefore, our margin of superiority over the Dow has narrowed somewhat. Currently, the over-all return from the Dow is about minus 8 1/2%. I would estimate our position at approximately plus 11 1/2 %. Giving effect to the allocation to the general partner, this means the limited partners are plus approximately 10% before monthly payments. If prices remain the same at yearend, partners who have withdrawn at the rate of 1/2 of 1% monthly will have capital accounts approximately 4% above the figure at the beginning of the year.

All commitment letters become absolutely final on December 31st. Should you wish to modify this letter in any way, it is essential that you contact me either in writing or verbally before the close of business on the 31st.

Cordially,

Warren E. Buffett

There are a few noteworthy items in this letter:

· Buffett provided tax information and guidance to his partners (and/or their tax advisors). While this may be something that any investment fund would do, he goes a step further. He advises them how to avoid possible penalties for underestimating tax payments. However, while doing so, I think he may also be providing a strategy for some partners to pay the minimum tax possible while avoiding penalties for underpayment. If partners make tax payments on the basis of actual 1962 tax, that might be less than they would ultimately owe in 1963 taxes if partner capital accounts have increased since 1962 (probable if you’re in the Buffett partnership) and proportionate share of partnership income increases in 1963 (also possible – Note: Partnership returns in all previous years of operation but one were higher). Thus, if partners pay lower tax throughout 1963 than is ultimately due, they can have that unpaid tax money working for their benefit until they have to settle up their 1963 tax bill with the IRS. I just keep thinking: Who wouldn’t want tax advice from Warren Buffett?

· The next item that I wanted to highlight is that Warren Buffett wrote a letter on Nov.1, to his partners. Unfortunately, I don’t have that letter, so I can’t comment on what he wrote on Nov. 1. However, he does say that “our margin of superiority over the Dow has narrowed somewhat” – which must mean that the partnership’s margin of superiority was higher on Nov. 1 than it is on Dec. 24. Buffett notes that as of Dec. 24, the “over-all return from the Dow is about minus 8 1/2%” and he estimates the partnership’s position “at approximately plus 11 1/2%.” This would indicate an approximate 20 percentage point advantage over the Dow as of Dec. 24. Thus, the partnership must have had a greater than 20 percentage point advantage over the Dow as of Nov. 1. Very impressive. (For your reference, as of July 6, 1962, the partnership held a 14.2 percentage point advantage over the Dow -- see my comments on the First Half of 1962).

· Lastly, I just plain find it interesting that, in the same year in which the overall return from the Dow was about minus 8 1/2%, a limited partner in the Buffett partnership could have withdrawn 6% of their 1962 beginning capital account (i.e. 1/2 of 1% monthly = 6% annually) and still had their ending capital account be 4% higher. It just goes to show you that the Buffett partnership really did operate differently than just owning the companies that made up the Dow.

Thanks for reading along. Next time, we’ll take a look at the 1962 partnership letter.

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